A Bright Future Beyond Yahoo

Charles Carlson, editor of the DRIP Investor, says that even after its proposed deal to buy Yahoo collapsed, Microsoft remains a technology power.

For the first time in five years, the number of companies in 2007 boosting their dividends declined nearly 6% from the previous year, according to Standard & Poor’s. And the slowdown in dividend growth continued in the first quarter of 2008. Through the first three months of this year, 19% fewer companies raised dividends than in the year-earlier quarter.

Even more alarming, 83 companies decreased their dividends during the first quarter, according to S&P. That’s up from just 19 in the same period in 2007 and is the highest number of dividend decreases since 1991.

Perhaps the biggest reason for the slowdown is that companies of all stripes have become much more conservative in their cash management. That’s not surprising given the uncertain economy, slowdown in corporate profits in a number of industries, and the generally tattered balance sheets of companies in the financial sector.

Microsoft (Nasdaq: MSFT) has pulled back since the end of January, as investors [were] concerned about the company’s takeover offer for Yahoo. Microsoft offered Yahoo a cash-and-stock deal valued at $31 per share. Yahoo resisted Microsoft’s overtures, and Wall Street worried that Microsoft would raise its offer to secure the deal. (Microsoft eventually offered $33 a share, which Yahoo rejected, although there is speculation Microsoft will come back with another offer in the future—Editor.)

For investors who can look past the Yahoo deal, the future is extremely bright for Microsoft. The company continues to generate huge amounts of cash from its Windows franchise. And other businesses, such as its Xboxunit, are starting to make nice contributions to revenue and profit.

Microsoft is the dominant software player in the PC market. The Windows operating system and Office business software provided 58% of revenue in the six months ended December 2007. Another 20% comes from server software. The entertainment unit, including the Xbox, accounts for around 17% of revenue and generated $524 million in profits. The money-losing MSN Internet unit (5% of revenue) is a laggard in search and search-based advertising, which is one reason Microsoft [made] the play for Yahoo.

Microsoft should earn in the vicinity of $1.87 per share for fiscal 2008 ending in June. The stock trades at 16x earnings, a fairly modest valuation for a firm generating billions a year in cash flow and where earnings are growing at a 20%-plus clip. (Its dividend yield is 1.5%—Editor.)

Downside risk appears limited to the $27 level, and the stock should move into the mid-$30s once there is a resolution to the Yahoo situation. (It closed just below $30 Tuesday—Editor.)

Microsoft offers a direct-purchase plan whereby any investor may buy the first share and every share directly from the company. Minimum initial investment is $1,000.